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Research Roundtable: Gundlach, Rodriguez, Others

Our expert panel sees turbulence — and opportunity — in the year ahead.

History makes clear that presidential election years are usually favorable for the securities markets. Here’s hoping history repeats itself.

Amid uncertainties about the U. S. economy and widespread worries over the European banking crisis, this year’s Research Roundtable of eminent investment experts is markedly mixed as to what the new year will bring.

Indeed, the market correction of this past summer and fall and the struggling economic recovery served only to raise the nation’s angst quotient and refuel negative sentiment, even as contrarians say the latter could turn out to be a positive indicator for next year.

No doubt 2012 will be an important year for our country; and while it is particularly challenging to forecast the 12 months ahead, our panelists are confident that astute investment professionals using the right strategies can successfully steer clients through the choppy seas.

Once again, it will be a stock picker’s year, according to the experts, with the accent on sectors that include industrials, technology, energy and health care. When it comes to bonds, the watchword is wariness.

In mid-October 2011, here’s what our Roundtable guests predicted for the year ahead.

Robert Rodriguez (Los Angeles) CEO, First Pacific Advisors; advisor to FPA Capital, FPA New Income funds. Firm manages assets of $16.2 billion. FPA Capital’s compounded rate of return from July 1984 launch to Sept. 30, 2011, is 14.39 percent. FPA New Income hasn’t had a down year in 33.

What’s the state of the market right now?

Gundlach: Half-way prepared for a hurricane, half-way hoping it doesn’t land on shore. A kind of no-man’s land.

Rodriguez: Tenuous.

Fisher: Sentiment disconnected from fundamentals. We’ve been through a major full-scale correction within a bull market.

Buckingham: Schizophrenic, driven by news out of Europe.

Tell me your outlook for the economy and stock market?

Rodriguez: From a standpoint of health care and fiscal policy, 2012 is the most important year in 80. I’m decidedly cautious. Europe is in or near recession. The odds are increasing north of 50 percent that we’ll be in recession next year. Several quarters of economic growth will have a 1 percent handle. The stock market will be facing both profitability and governmental issues.

We’ve had the worst recovery on record. While [Federal Reserve chair] Ben Bernanke is trying to improve the situation, he’s really harming it.

Fisher: Bernanke is nothing but a disaster. Where’s duct tape when we need it!

So, do you agree with Mr. Rodriguez that we’re on the road to recession?

Fisher: We’re not in recession, nor are we headed into one in 2012. The economy will be okay but not gangbusters. The non-U.S. world on average will be stronger than the U.S. world. [But] our economy is much stronger than people think, quite robust. Leading economic indicators are high and rising; yield curves are steep. What’s weak is our sentiment.

Next year we’ll have a bull market with gusto. The aftermath of a correction is usually an up mode. It will be a nicely above-average year, a year to be invested in equities as you’d ever be.

Buckingham: We’ll avoid recession. Economic indicators are not coincident with negative GDP growth. We’ve already discounted a mild recession. The economy is strong. I expect stocks to be up more than 10 percent. Next year should be a very good time to focus on dividend-paying value stocks since they’ve underperformed in the last couple of years.

Gundlach: With this economy, you have one foot on the pier and one foot in the rowboat, and the boat is drifting — so you’re probably going to end up in the water. There are a lot of structural issues; and because of that, it’s a difficult investment environment. That’s not a very rosy outlook, but investing is about reality. Against this backdrop, the markets should be kind of cheap.

Are we headed toward another financial crisis?

Rodriguez: Unless there is fundamental structural budgetary reform in the Congress, I don’t trust them.

What’s the biggest threat to the markets next year?

Rodriguez: Continued political incompetence with regard to our fiscal issues.

Buckingham: An unpleasant event out of Europe. [Also] there’s not a lot of confidence in the system, and there’s fear that something could blow up. There are still unknowns on the balance sheets of many financial institutions.

Fisher: Probably something that creates geopolitical instability because we’re not looking for it.

Gundlach: The collapse of the European banking system.

How do you see corporate earnings shaping up next year?

Rodriguez: [Forecasts] are too optimistic. [Considering] what a lot of corporations have done to enhance their profit margins over the last several years, there aren’t many more rabbits in the hat.

Fisher: Earnings have been very strong and will continue strong.

Gundlach: I don’t find it useful to predict corporate earnings in understanding the way the market goes. These days, it’s based upon seismic shifts of policy and politics — choices made at a political level rather than: Is someone going to beat the Street by a few cents?

Do you expect inflation or deflation next year?

Rodriguez: Right now, we have deflation and inflation simultaneously: deflation in home prices and inflation in commodity prices. If we do not address our fiscal issues within no longer than three years, you could see long-term monetary inflation taking hold. Congress has been irresponsible.

Rodriguez: They are absolutely terrible. We continue to run a very, very short duration bond fund, which is killing us. But we don’t like the risk in the bond market and haven’t for many years.

Gundlach: Government bonds are no longer what I would consider an investment; they’re now a hedge. It’s impossible to see yields fall on short-term bonds because they’re at zero. Painfully low interest rates will be with us as long as there’s economic malaise and rhetoric about addressing the deficit.

We’ve been focusing on the higher yields available in areas of the mortgage-related market. We made more money this year in government bonds than in anything else. But going forward, the yield isn’t there in junk government bonds. Corporate bonds will be a good buy.

Next year is a presidential election. What will its impact be on markets?

Fisher: Election years are almost never negative for the stock market, and this one should be particularly good. Normally, when we initially elect a Republican, the market is gangbusters. When we reelect a Democrat, it’s pretty darn good. And next year we’ll do one or the other.

Gundlach: This election is going to be the most significant one for politics and financial markets in our lifetime. It’s the taxes-are-too-darn-low party running against the spending-is-too-darn-high party. Whoever gets a mandate will have to start implementing it in February 2013, and either one will be problematic for the economy almost immediately: if you cut spending a lot, it leads to negative economic growth; raising taxes by a lot takes money out of the private economy, which has a similar effect.

Fisher: Moving forward, the things that should do best are economically sensitive. The focus needs to be on stocks that will benefit from an improved perception about the economy — sectors such as materials, industrials, technology and energy.

Gundlach: I like producers of resource commodities. What really holds value are companies that produce things that are necessary, like copper, food, cement.

Rodriguez: No one sector shows up yet. [We’ve] invested in a couple of stocks in technology, one in financial services and one in health care. One stock [I’ll mention] is Oshkosh Corp., a specialty vehicle manufacturer involved with the military and some municipalities. It’s setting new lows.

What’s your forecast for international investing?

Buckingham: Foreign markets have suffered bigger declines than the U.S. market, and that makes me a little more optimistic than I usually might be about foreign. That potential strength abroad can be played by investing in companies that trade on the U.S. exchanges.

Fisher: I’m not optimistic about emerging markets stocks because we had too much optimism, and people are looking for a bottom. If they don’t get the bottom, they stop looking for it.

Gundlach: One of the most important things to look at is the Shanghai stock market. China is slowing down in growth, and you can see it in the Shanghai market — it seems to never go up. It’s been dropping week by week pretty much all year.

Rodriguez: In the last month or so, some raw materials currencies, like the Australian dollar and Canadian dollar, have been getting hit. That signifies there is a perception of greater risk in raw materials internationally — and that implies slower growth.

What impact will increased financial regulation have on the markets in 2012?

Fisher: All bad. Our salvation has never been regulation. As Adam Smith said, the greatest regulator is competition itself.

Buckingham: I don’t see it having real negative impact on the stock market, even if it does have a modest [negative] effect on profitability.

What investment strategy do you recommend for next year?

Rodriguez: Make real selection decisions. In this kind of slow-growth environment, a diversified portfolio of securities and being pretty much fully invested isn’t going to get you there.

Much of what goes on in [professional] money management is a form of “closet indexing.” If they’re bullish on an industry and it represents 10 percent of the index, they’ll own 11 percent or 12 percent. If negative, they’ll own 8 percent. I’m being a little too critical about the percentages — but the diversified portfolio has not been a winner.

Gundlach: The strategy that has succeeded in our bond funds: a mix of assets where you have some government credit to hedge against volatility.

Do you expect the unusually high level of volatility to continue?

Buckingham: Yes, because these days we’re dominated by the whims of speculators, and so much is driven by high-frequency traders. [But] I love volatility because that’s what gives me the opportunity to buy. This kind of market will favor individual stock pickers who are nimble.